Working Paper No. 14-33:
Salience and Sin: Designing Taxes in the New Sin Era

Author(s):

Abstract:

Tax
salience reflects the extent to which consumers take into account the after-tax
cost of a good or service prior to making their consumption decision. Recent empirical work on tax salience has
revealed something that is perhaps intuitive, but nevertheless important to the
design of sin taxes. Taxpayers are more
likely to make consumption decisions based on pre-tax rather than post-tax
prices when the salience, or visibility, of a tax is diminished. Thus, consumers are less likely to change
their demand for a particular product if shelf prices are tax-exclusive rather
than tax-inclusive. Economically, this
makes low salience taxes mimic some of the benefits of taxes on inelastically
demanded goods. Because a taxpayer’s
demand change in response to a tax increase is diminished, the deadweight loss
generated by the imposition of the tax can be reduced. Notwithstanding the
potential for efficiency gains, politicians and academics alike have expressed
various fairness, distributional, and normative concerns regarding the use of
low salience taxes. In fact, a number of
countries already require tax-inclusive pricing for consumer products in order
to purportedly preserve consumer awareness and transparency.

In contrast, I argue
that lawmakers should not rush to reject tax-exclusive pricing outright and
should continue to explore the benefits of low salience taxes in select
situations. To the extent lawmakers are
able to minimize economic distortions the concerns that have been expressed are
not always fatal. I develop a new
analytical rubric for tax salience, and determine that the appropriate use of
salience for any particular tax is dependent on a number of factors. These factors include the price elasticity of
demand, the potential for countervailing income effects, and whether the tax is
intended to raise revenue or modify taxpayer behavior. As a normative matter, I find that
selectively implemented low salience taxes can be beneficial. However, I do not believe they should be
universally implemented in sin tax design.
In fact, in another expansion on the current literature, I argue that in
certain situations lawmakers may best benefit from high salience taxes. I propose that these taxes may have
efficiency benefits when lawmakers are seeking to influence taxpayer
behavior. Ultimately, while it is
difficult to draw definitive conclusions regarding the optimal use of tax
salience given that many empirical and theoretical aspects of salience have yet
to be developed, the empirical work done to-date suggests that the impact of
tax salience on tax design may be significant and is worth exploring.